Local Content Requirements Versus Tariff Equivalents: How We Measure Matters

• Published date: 01 May 2017
• Date: 01 May 2017
• Author: Dorothee Flaig,Susan F. Stone
• DOI: http://doi.org/10.1111/twec.12426

Local Content Requirements Versus Tariff

Equivalents: How We Measure Matters

Dorothee Flaig and Susan F. Stone

OECD, Trade and Agriculture Directorate, Paris, France

1. INTRODUCTION

IN the wake of the economic crisis in 2008, governments came under intense pressure to

provide quick solutions to large employment problems. At the same time, many govern-

ments felt at a loss to effectively stimulate domestic activities given the large influence global

value chains (GVCs) and international fragmentation were seen to have on domestic produc-

tion. However, as the crisis itself so starkly illustrated, the inter-reliance of economies has

never been greater and the traditional go-to remedy of previous downturns, that is tariff

increases, suddenly became a self-defeating policy.

The implementation of tariffs or quotas was further inhibited by the monitoring process

that was put in place under the auspices of the G20. The G20 came to prominence in the

wake of the crisis and was quick to condemn any use of trade distorting tariff measures: ‘We

underscore the critical importance of rejecting protectionism and not turning inward in times

of financial uncertainty. In this regard, within the next 12 months, we will refrain from rais

ing new barriers to investment or to trade in goods and services, imposing new export restric-

tions, or implementing World Trade Organization (WTO) inconsistent measures to stimulate

exports’(G20 Statement released 15 November 2008). This pledge has been repeated at the

majority of subsequent G20 meeting.

However, as time passed and recoveries faltered, governments increasingly sought other

ways to promote domestic economies. In a time of budgetary austerity, various types of local-

isation requirements began to be seen as a way to boost domestic industry without incurring

significant fiscal outlay. By mandating local sourcing of goods and services, the real cost of

these policies is born by a large group of purchasers and competing international suppl iers

and thus are difficult to measure or track. However, precisely because these measures are opa-

que, the accurate identification and measurement of their costs is an important trade policy

concern.

The purpose of this paper was to outline a new approach to the measurement of localisa-

tion barriers to trade, specifically in the form of local content requirements (LCRs). This

paper proceeds by first discussing the rise in the use of LCRs as a trade policy tool. It then

develops a quantitative approach to modelling these policies in a CGE framework. This paper

argues that implementing these measures in their quantitative form, as opposed to converting

them to tariff equivalents, has important implications for measured outcomes. The price mech-

anism implied by the tariff equivalents fails to capture the more subtle spillover effects

The CGE model employed in this study was developed by and for OECD: Stone et al. (2015) and

OECD (2015), METRO version 1 model documentation, Trade and Agriculture Directorate, OECD, Jan-

uary. The authors are grateful to Frank van Tongeren for comments on this work as well as to partici-

pants of the 17th annual GTAP conference and various OECD seminars where this work has been

presented. This work should not be reported as representing the official views of the OECD or of its

member countries. The opinions expressed and arguments employed are those of the authors.

©2016 John Wiley & Sons Ltd 931

The World Economy (2017)

doi: 10.1111/twec.12426

The World Economy

observed in the market place. Leaving the LCRs in their quantitative form allows these costs

to be better captured by the analysis.

2. LOCAL CONTENT REQUIREMENTS

The incidence of non-tariff measures (NTMs), while applied in varying forms for years,

has been growing since the crisis. In fact, there is evidence that the rise in globalisation,

through GVCs and other cross-border interactions, has contributed to both the rise in the use

of NTMs as well as to their cost (Osgood, 2012). In this world of GVCs, the cost of protec-

tion can be higher than generally thought (Miroudot et al., 2013). As intermediate inputs are

traded across borders multiple times, downstream firms end up paying higher costs for

imported inputs in addition to the barriers they face on their own exports. The effective bur-

den for the exporter can thus be several orders of magnitude over what nominal tariffs or

NTMs show. Consequently, firms are campaigning vigorously for the monitoring and elimina-

tion of a variety of NTMs.

1

Among the fastest growing NTMs are LCRs. Historically, LCRs were attached to foreign

direct investment (FDI) as a means of generating domestic jobs. By mandating a certain per-

centage of inputs to be purchased domestically, or a certain percentage of people employed

locally, domestic governments were looking to guarantee the realisation of the anticipated

spillovers from these projects.

2

However, the motivation for many of the LCRs put in place

since the 2008 crisis has gone beyond job creation. Today, LCRs are being used as a way to

develop expertise in emerging high technology and renewable energy sectors, for example.

Related to this is the desire to obtain a portion of the vast and lucrative business associated

with large multinationals and GVC trade (Hufbauer et al., 2013).

Local content requirements are similar to import quotas in that they use quantities rather

than prices to influence the geographic distribution of business. The political appeal of LCRs

is strong as they represent no explicit financial outlays. As opposed to price preferences for

domestic firms, tariffs and subsidies, the cost imposed on purchasers (whether they be house-

holds or firms) is opaque and often totally hidden with LCRs. The WTO and many RTA

agreements remain unclear with respect to quantity restrictions. For example, quantity restric-

tions only violate provisions under the Government Procurement Agreement (GPA) of the

WTO for a set of specific activities agreed to in the GPA. LCRs tied to services seldom con-

flict with obligations under GATS because, for the most part, those commitments are limited

to pre-existing market access.

Various sources estimate that between 90 and 200, new LCR measures have been put in

place since 2008.

3

According to Hufbauer et al. (2013), countries have considered or imple-

mented almost 120 new LCRs. They define these LCRs as follows:

Classic mandatory LCRs set as percentages of goods or services;

Tax, tariff or price concessions conditioned on local procurement;

1

For recent discussions of this topic see: http://www.oecd.org/fr/tad/echdev/international-business-dialo-

gue-2013.htm and http://www.digitaleurope.org/DocumentDownload.aspx?Command=Core_Download&

EntryId=615.

2

LCRs had the added benefit of generating greater support in the domestic market for many invest-

ment projects. See for example, G€

org and Greenaway (2004) for a review.

3

See for example, the WTO G20 Monitoring Reports, Global Trade Alert and European Commission’s

Market Access Database.

©2016 John Wiley & Sons Ltd

932 D. FLAIG AND S. F. STONE